Five golden rules to retire rich

There was a time when retirement planning was all about finding and retaining a well-paying job either in the public sector or in large reputable firms. Most jobs were for the lifetime and higher interest on bank deposits and government bonds meant that employees could leave their retirement to the organisation’s finance department that handled their provident funds. 

Another option was to invest in an endowment or whole life insurance plan from a life insurance company.

Those days are behind us. The fresh hiring by the public sector and the government has slowed down to a trickle. In the private sector long-term jobs are now a rarity and lifetime employment with a single organisation is now next to impossible. 

Besides, salaries in the private sector are now structured in a way that greatly reduces the employer’s and employee's contribution to the provident fund and gratuity, resulting in a much lower financial pool at the time of retirement. 

Employees also don’t complain as lower PF contribution translates into higher in-hand salary. The retirement anxiety hits home as the youth makes way for middle age and big-ticket expenses from house EMIs to children’s education start piling up.

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Suddenly, many professionals realise that their meagre PF contribution and lower interest rates on them may not be enough to provide financial security for their family post-retirement. They also realise that passive savings and investment may not be sufficient to fund even big-ticket expenses such as weddings or a child's higher education.

That’s why you should start retirement planning from the day you receive your first salary or paycheck. Here are five golden rules that anyone can follow to retire rich:

1.  Choose a job with higher basic pay over one with higher cash in hand. Retirement benefits such as employee provident fund deduction and gratuity are based on basic salary and not on the overall cost to the company (CTC). 

The CTC includes other payments such as house rent allowances, special allowances, conveyance and transport allowances and variable pay among others. Latter will fatten the overall CTC and your cash in hand but a lower basic pay means lower savings in your EPF account. So you will retire relatively poor even if you enjoyed a higher salary in your working life. So always go for a job or organization that offers higher basic pay for a similar overall CTC package.

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2.  Start by saving a quarter of your take-home salary. If you are stuck in a job or an organisation that offers low basic pay or one that doesn’t pay EPF, then start saving on your personal account. Begin by saving 10 percent of your take-home income in a long-term instrument such as a bank recurring deposit and increase the saving ratio to at least 25 percent over the next three years. 

Put the savings in instruments that make it a little difficult or cumbersome to spend the money on impromptu purchases. 

Remember discipline is everything in financial planning. You will be able to create a corpus only if you save religiously for at least 15 years or more.

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3.  Maximise your income tax savings by investing in EPF, PPF and NPS. Employee and public provident funds and the New Pension Schemes (NPS) remain the best way to save for the long-term and save income tax at the same time. 

You can save tax up to Rs 1.5 lakh per annum through EPF and PFF and an additional Rs 50,000 through NPS. 

If your annual contribution is less than this amount, ask your organisation to raise your (employee’s) contribution and top it up by opening an NPS account. Choose an auto-invest option in NPS that frees you from the headache of asset allocation.

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4.  Invest in a low-cost index equity mutual fund. There are basically two types of equity mutual funds – actively managed diversified equity funds and passive index funds. In actively managed funds, the fund manager invests the money in a basket of stocks that he or she believes will outperform the broader market in the future. Stock selection and the constant monitoring of the portfolio consume resources and capital. 

Active funds recover this cost by levying management fees (or expense ratio) that could eat up to a quarter of the fund's returns over the longer term. Most equity mutual funds in India are actively managed but it is increasingly becoming difficult for the fund managers of actively managed funds to beat the benchmark indices such as BSE Sensex or the Nifty50 Index. For example, only a quarter of diversified equity funds managed to beat the Sensex in 2022 which defeats the purpose of investing in these high-cost funds.

Low-cost passive index funds also called exchange-traded funds whose portfolio mirrors benchmark indices such as Sensex or Nifty 50 are best for retirement planning. 

Low expense ratios of these funds translate into higher net returns in the longer term. Besides, you are not taking any risk on the fund sponsor or the fund manager.

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5.  Take exposure in multi-asset or hybrid funds. Putting all your money in equity funds is risky. So diversify your portfolio by investing in balanced or hybrid funds that invest in both equity as well as the bond market. Some even invest in gold. 

In good times these funds give lower returns than pure equity funds but these funds outperform when markets turn volatile. This has been proved right in 2022 when the majority of pure equity funds underperformed but multi-asset or hybrid funds have done relatively better.

As a thumb rule never put all your funds in one or two top-performing mutual funds. Spread over money in at least three funds in every category to protect yourself from concentration risk.

Happy retirement planning!

(Karan Deo Sharma is a Mumbai-based finance and equity markets specialist).

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